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Well, it’s official – inflation is definitely back. In the UK there are two main measures of inflation, the consumer price index and the retail price index. The CPI is a newer measure (it started in the late 1980s and is more consistent with the way inflation is measured in continental Europe). The UK switched to using the CPI as the target measure for inflation in 2003. The main difference between the CPI and RPI is that the RPI has a higher weighting towards housing and also includes mortgage interest and property depreciation. There is also a subtle difference in the way in which price increases are calculated which results in the RPI always being higher than the CPI by around 0.5 per cent per annum. CPI is currently 3 per cent and RPI is currently 4.2 per cent.

If we look at historical RPI inflation, there was a dramatic increase in the 1970s after a fairly benign period of price increases during the ‘50s and ‘60s. This inflationary increase was caused by the shock of sudden increases in the price of oil. This is all starting to look quite familiar and mirrors what is happening to current oil prices. From the low point in 1997 to date, the price of oil has risen by around 1200 per cent (starting at less than $10 per barrel and recently peaking at over $130 per barrel).

To counter these massive increases, the UK government has been calling for discussions with the major oil exporters. While this is a good thing for the UK and ultimately the Western world, there is likely to be indifference from the major oil producers as high oil prices are a good thing for them and their shareholders. A better course of action for the government would be to ease prices in the UK by cutting tax on petrol, something that is being demanded by the haulage companies and fishermen.

Cutting the tax levy on fuel may be easier said than done as an average of over £36bn per annum was borrowed between 2003 and 2007, when the UK economy was booming. This is anticipated to rise to £40bn this year and so there is no room to reduce the tax on petrol as there is no fall back financially. This high public borrowing coupled with the current rising inflation is making bonds unattractive. Equities, which have suffered over the last year, are now at very attractive prices and are a much better hedge against inflation.

For asset managers, advisers and their clients, a policy of maintaining a high weighting towards equities is the correct strategy. This can be uncomfortable in the short term, as has been the case over the last six months, during which portfolios have generally lost money. However, it is the right course of action for the longer term.